The Tax Cuts and Jobs Act (TCJA) provides substantial tax incentives for small businesses, especially manufacturers, distributors, and retailers. These incentives include:
1. Using the Cash Method
2. Treating Inventories as Non-Incidental Materials
3. Exemption From the New Interest Expense Limitation
By Rene Schaefer, CPA MST
The Tax Cuts and Jobs Act (TCJA) provides substantial tax incentives for small businesses with average gross receipts of $25 million or less for the three prior years. These incentives are especially applicable to small businesses with inventories, such as manufacturers, distributors, and retailers.
The three incentives that the TCJA allows for these types of companies are: using the cash method for tax purposes, treating inventory costs as non-incidental materials, and exempting them from the new interest expense limitation.
Using the Cash Method
Businesses may use the cash method for tax purposes, even though the business keeps its books and records on the accrual basis. Previously, businesses could not use the cash method if they had gross receipts over $10 million, maintained inventories, or were a C corporation or had a C corporation partner with gross receipts over $5 million.
When using the cash method for tax purposes, income is recognized when the cash is received and expenses are deductible when they are paid. The cash method provides a better matching of cash flow with taxes paid and more flexibility in tax planning.
In the year the change is made, there is usually significant tax savings. C corporations have the flat tax rate of 21%, so there may be some planning needed if the cash method creates a loss. For S corporations, partnerships, and sole proprietorships, strategic planning can spread out the tax savings over two years by taking advantage of reducing taxes at higher tax rates. As a business grows, the tax savings increase. Changing to the cash method requires an Accounting Method Change (Form 3115).
Treating Inventories as Non-Incidental Materials
Businesses may treat inventories as non-incidental materials and supplies or conform to the method the business uses for financial statements or its books and records. Under the previous law, businesses were required to capitalize materials, labor, overhead, and related general and administrative expenses (uniform capitalization) for tax purposes. This change also requires an Accounting Method Change (Form 3115).
Exemption From the New Interest Expense Limitation
The TCJA added a new provision that limits the interest expense a business can deduct. For 2018 through 2021, interest expense is deductible to the extent it is less than 30% of taxable income plus interest expense, depreciation, and amortization. After 2021, interest expense is deductible to the extent it is less than 30% of taxable income plus interest expense only. This interest expense limitation does not apply to small businesses.
There are many other tax incentives available to manufacturers, distributors, and retailers, such as the Section 179 expense election up to $1 million and 100% bonus depreciation. It is also important to consider what type of entity the business should use for tax purposes (C corporation, S corporation, LLC) with the different rate structures and limitations under the new tax law.
Businesses should give careful consideration to planning with the TCJA. There are many incentives that can result in significant tax savings. Please contact your Clark Nuber professional or Rene Schaefer to understand how this new tax law can help you.
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